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Filing 2011 Tax Returns Free

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Filing 2011 Tax Returns Free

Filing 2011 tax returns free 8. Filing 2011 tax returns free   Qualified Tuition Program (QTP) Table of Contents Introduction What Is a Qualified Tuition ProgramDesignated beneficiary. Filing 2011 tax returns free Half-time student. Filing 2011 tax returns free How Much Can You Contribute Are Distributions TaxableFiguring the Taxable Portion of a Distribution Additional Tax on Taxable Distributions Rollovers and Other TransfersRollovers Changing the Designated Beneficiary Introduction Qualified tuition programs (QTPs) are also called “529 plans. Filing 2011 tax returns free ” States may establish and maintain programs that allow you to either prepay or contribute to an account for paying a student's qualified education expenses at a postsecondary institution. Filing 2011 tax returns free Eligible educational institutions may establish and maintain programs that allow you to prepay a student's qualified education expenses. Filing 2011 tax returns free If you prepay tuition, the student (designated beneficiary) will be entitled to a waiver or a payment of qualified education expenses. Filing 2011 tax returns free You cannot deduct either payments or contributions to a QTP. Filing 2011 tax returns free For information on a specific QTP, you will need to contact the state agency or eligible educational institution that established and maintains it. Filing 2011 tax returns free What is the tax benefit of a QTP. Filing 2011 tax returns free   No tax is due on a distribution from a QTP unless the amount distributed is greater than the beneficiary's adjusted qualified education expenses. Filing 2011 tax returns free See Are Distributions Taxable , later, for more information. Filing 2011 tax returns free    Even if a QTP is used to finance a student's education, the student or the student's parents still may be eligible to claim the American opportunity credit or the lifetime learning credit. Filing 2011 tax returns free See Coordination With American Opportunity and Lifetime Learning Credits, later. Filing 2011 tax returns free What Is a Qualified Tuition Program A qualified tuition program is a program set up to allow you to either prepay, or contribute to an account established for paying, a student's qualified education expenses at an eligible educational institution. Filing 2011 tax returns free QTPs can be established and maintained by states (or agencies or instrumentalities of a state) and eligible educational institutions. Filing 2011 tax returns free The program must meet certain requirements. Filing 2011 tax returns free Your state government or the eligible educational institution in which you are interested can tell you whether or not they participate in a QTP. Filing 2011 tax returns free Qualified education expenses. Filing 2011 tax returns free   These are expenses related to enrollment or attendance at an Eligible educational institution (defined later). Filing 2011 tax returns free As shown in the following list, to be qualified, some of the expenses must be required by the institution and some must be incurred by students who are enrolled at least half-time. Filing 2011 tax returns free See Half-time student , later. Filing 2011 tax returns free The following expenses must be required for enrollment or attendance of a Designated beneficiary (defined later) at an eligible educational institution. Filing 2011 tax returns free Tuition and fees. Filing 2011 tax returns free Books, supplies, and equipment. Filing 2011 tax returns free Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible educational institution. Filing 2011 tax returns free Expenses for room and board must be incurred by students who are enrolled at least half-time. Filing 2011 tax returns free The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts. Filing 2011 tax returns free The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student. Filing 2011 tax returns free The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution. Filing 2011 tax returns free You will need to contact the eligible educational institution for qualified room and board costs. Filing 2011 tax returns free    For tax years after 2010, the purchase of computer technology or equipment is only a qualified education expense if the computer technology or equipment is required for enrollment or attendance at an eligible institution. Filing 2011 tax returns free Designated beneficiary. Filing 2011 tax returns free   The designated beneficiary is generally the student (or future student) for whom the QTP is intended to provide benefits. Filing 2011 tax returns free The designated beneficiary can be changed after participation in the QTP begins. Filing 2011 tax returns free If a state or local government or certain tax-exempt organizations purchase an interest in a QTP as part of a scholarship program, the designated beneficiary is the person who receives the interest as a scholarship. Filing 2011 tax returns free Half-time student. Filing 2011 tax returns free   A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time academic workload for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled. Filing 2011 tax returns free Eligible educational institution. Filing 2011 tax returns free   For purposes of a QTP, this is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. Filing 2011 tax returns free S. Filing 2011 tax returns free Department of Education. Filing 2011 tax returns free It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. Filing 2011 tax returns free The educational institution should be able to tell you if it is an eligible educational institution. Filing 2011 tax returns free   Certain educational institutions located outside the United States also participate in the U. Filing 2011 tax returns free S. Filing 2011 tax returns free Department of Education's Federal Student Aid (FSA) programs. Filing 2011 tax returns free   How Much Can You Contribute Contributions to a QTP on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary. Filing 2011 tax returns free There are no income restrictions on the individual contributors. Filing 2011 tax returns free You can contribute to both a QTP and a Coverdell ESA in the same year for the same designated beneficiary. Filing 2011 tax returns free   Are Distributions Taxable The part of a distribution representing the amount paid or contributed to a QTP does not have to be included in income. Filing 2011 tax returns free This is a return of the investment in the plan. Filing 2011 tax returns free The designated beneficiary generally does not have to include in income any earnings distributed from a QTP if the total distribution is less than or equal to adjusted qualified education expenses (defined under Figuring the Taxable Portion of a Distribution , later). Filing 2011 tax returns free Earnings and return of investment. Filing 2011 tax returns free    You will receive a Form 1099-Q, from each of the programs from which you received a QTP distribution in 2013. Filing 2011 tax returns free The amount of your gross distribution (box 1) shown on each form will be divided between your earnings (box 2) and your basis, or return of investment (box 3). Filing 2011 tax returns free Form 1099-Q should be sent to you by January 31, 2014. Filing 2011 tax returns free Figuring the Taxable Portion of a Distribution To determine if total distributions for the year are more or less than the amount of qualified education expenses, you must compare the total of all QTP distributions for the tax year to the adjusted qualified education expenses. Filing 2011 tax returns free Adjusted qualified education expenses. Filing 2011 tax returns free   This amount is the total qualified education expenses reduced by any tax-free educational assistance. Filing 2011 tax returns free Tax-free educational assistance includes: The tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. Filing 2011 tax returns free Taxable earnings. Filing 2011 tax returns free   Use the following steps to figure the taxable part. Filing 2011 tax returns free Multiply the total distributed earnings shown in box 2 of Form 1099-Q by a fraction. Filing 2011 tax returns free The numerator is the adjusted qualified education expenses paid during the year and the denominator is the total amount distributed during the year. Filing 2011 tax returns free Subtract the amount figured in (1) from the total distributed earnings. Filing 2011 tax returns free The result is the amount the beneficiary must include in income. Filing 2011 tax returns free Report it on Form 1040 or Form 1040NR, line 21. Filing 2011 tax returns free Example 1. Filing 2011 tax returns free In 2007, Sara Clarke's parents opened a savings account for her with a QTP maintained by their state government. Filing 2011 tax returns free Over the years they contributed $18,000 to the account. Filing 2011 tax returns free The total balance in the account was $27,000 on the date the distribution was made. Filing 2011 tax returns free In the summer of 2013, Sara enrolled in college and had $8,300 of qualified education expenses for the rest of the year. Filing 2011 tax returns free She paid her college expenses from the following sources. Filing 2011 tax returns free   Gift from parents $1,600     Partial tuition scholarship (tax-free) 3,100     QTP distribution 5,300           Before Sara can determine the taxable part of her QTP distribution, she must reduce her total qualified education expenses by any tax-free educational assistance. Filing 2011 tax returns free   Total qualified education expenses $8,300     Minus: Tax-free educational assistance −3,100     Equals: Adjusted qualified  education expenses (AQEE) $5,200   Since the remaining expenses ($5,200) are less than the QTP distribution, part of the earnings will be taxable. Filing 2011 tax returns free Sara's Form 1099-Q shows that $950 of the QTP distribution is earnings. Filing 2011 tax returns free Sara figures the taxable part of the distributed earnings as follows. Filing 2011 tax returns free   1. Filing 2011 tax returns free $950 (earnings) × $5,200 AQEE  $5,300 distribution           =$932 (tax-free earnings)     2. Filing 2011 tax returns free $950 (earnings)−$932 (tax-free earnings)     =$18 (taxable earnings)  Sara must include $18 in income (Form 1040, line 21) as distributed QTP earnings not used for adjusted qualified education expenses. Filing 2011 tax returns free Coordination With American Opportunity and Lifetime Learning Credits An American opportunity or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. Filing 2011 tax returns free This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit. Filing 2011 tax returns free Example 2. Filing 2011 tax returns free Assume the same facts as in Example 1 , except that Sara's parents claimed an American opportunity credit of $2,500 (based on $4,000 expenses). Filing 2011 tax returns free   Total qualified education expenses $8,300     Minus: Tax-free educational assistance −3,100     Minus: Expenses taken into account  in figuring American opportunity credit −4,000     Equals: Adjusted qualified  education expenses (AQEE) $1,200           The taxable part of the distribution is figured as follows. Filing 2011 tax returns free   1. Filing 2011 tax returns free $950 (earnings) × $1,200 AQEE  $5,300 distribution           =$215 (tax-free earnings)     2. Filing 2011 tax returns free $950 (earnings)−$215 (tax-free earnings)     =$735 (taxable earnings)       Sara must include $735 in income (Form 1040, line 21). Filing 2011 tax returns free This represents distributed earnings not used for adjusted qualified education expenses. Filing 2011 tax returns free Coordination With Coverdell ESA Distributions If a designated beneficiary receives distributions from both a QTP and a Coverdell ESA in the same year, and the total of these distributions is more than the beneficiary's adjusted qualified higher education expenses, the expenses must be allocated between the distributions. Filing 2011 tax returns free For purposes of this allocation, disregard any qualified elementary and secondary education expenses. Filing 2011 tax returns free Example 3. Filing 2011 tax returns free Assume the same facts as in Example 2 , except that instead of receiving a $5,300 distribution from her QTP, Sara received $4,600 from that account and $700 from her Coverdell ESA. Filing 2011 tax returns free In this case, Sara must allocate her $1,200 of adjusted qualified higher education expenses (AQHEE) between the two distributions. Filing 2011 tax returns free   $1,200 AQHEE × $700 ESA distribution  $5,300 total distribution = $158 AQHEE (ESA)     $1,200 AQHEE × $4,600 QTP distribution  $5,300 total distribution = $1,042 AQHEE (QTP)   Sara then figures the taxable portion of her Coverdell ESA distribution based on qualified higher education expenses of $158, and the taxable portion of her QTP distribution based on the other $1,042. Filing 2011 tax returns free Note. Filing 2011 tax returns free If you are required to allocate your expenses between Coverdell ESA and QTP distributions, and you have adjusted qualified elementary and secondary education expenses, see the examples in chapter 7, Coverdell Education Savings Account under Coordination With Qualified Tuition Program (QTP) Distributions . Filing 2011 tax returns free Coordination With Tuition and Fees Deduction. Filing 2011 tax returns free   A tuition and fees deduction can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. Filing 2011 tax returns free Losses on QTP Investments If you have a loss on your investment in a QTP account, you may be able to take the loss on your income tax return. Filing 2011 tax returns free You can take the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Filing 2011 tax returns free Your basis is the total amount of contributions to that QTP account. Filing 2011 tax returns free You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23 (Schedule A (Form 1040NR), line 9), subject to the 2%-of-adjusted-gross-income limit. Filing 2011 tax returns free If you have distributions from more than one QTP account during a year, you must combine the information (amount of distribution, basis, etc. Filing 2011 tax returns free ) from all such accounts in order to determine your taxable earnings for the year. Filing 2011 tax returns free By doing this, the loss from one QTP account reduces the distributed earnings (if any) from any other QTP accounts. Filing 2011 tax returns free Example 1. Filing 2011 tax returns free In 2013, Taylor received a final distribution of $1,000 from QTP #1. Filing 2011 tax returns free His unrecovered basis in that account before the distribution was $3,000. Filing 2011 tax returns free If Taylor itemizes his deductions, he can claim the $2,000 loss on Schedule A (Form 1040). Filing 2011 tax returns free Example 2. Filing 2011 tax returns free Assume the same facts as in Example 1 , except that Taylor also had a distribution of $9,000 from QTP #2, giving him total distributions for 2013 of $10,000. Filing 2011 tax returns free His total basis in these distributions was $4,500 ($3,000 for QTP #1 and $1,500 for QTP #2). Filing 2011 tax returns free Taylor's adjusted qualified education expenses for 2013 totaled $6,000. Filing 2011 tax returns free In order to figure his taxable earnings, Taylor combines the two accounts and determines his taxable earnings as follows. Filing 2011 tax returns free   1. Filing 2011 tax returns free $10,000 (total distribution)−$4,500 (basis portion of distribution)     = $5,500 (earnings included in distribution)   2. Filing 2011 tax returns free $5,500 (earnings) x $6,000 AQEE  $10,000 distribution           =$3,300 (tax-free earnings)     3. Filing 2011 tax returns free $5,500 (earnings)−$3,300 (tax-free earnings)     =$2,200 (taxable earnings)                 Taylor must include $2,200 in income on Form 1040, line 21. Filing 2011 tax returns free Because Taylor's accounts must be combined, he cannot deduct his $2,000 loss (QTP #1) on Schedule A (Form 1040). Filing 2011 tax returns free Instead, the $2,000 loss reduces the total earnings that were distributed, thereby reducing his taxable earnings. Filing 2011 tax returns free Additional Tax on Taxable Distributions Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income. Filing 2011 tax returns free Exceptions. Filing 2011 tax returns free   The 10% additional tax does not apply to distributions: Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary. Filing 2011 tax returns free Made because the designated beneficiary is disabled. Filing 2011 tax returns free A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. Filing 2011 tax returns free A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration. Filing 2011 tax returns free Included in income because the designated beneficiary received: A tax-free scholarship or fellowship (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), or Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. Filing 2011 tax returns free Made on account of the attendance of the designated beneficiary at a U. Filing 2011 tax returns free S. Filing 2011 tax returns free military academy (such as the USNA at Annapolis). Filing 2011 tax returns free This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in section 2005(d)(3) of title 10 of the U. Filing 2011 tax returns free S. Filing 2011 tax returns free Code) attributable to such attendance. Filing 2011 tax returns free Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit (see Coordination With American Opportunity and Lifetime Learning Credits , earlier. Filing 2011 tax returns free ) Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment. Filing 2011 tax returns free Figuring the additional tax. Filing 2011 tax returns free    Use Part II of Form 5329, to figure any additional tax. Filing 2011 tax returns free Report the amount on Form 1040, line 58, or Form 1040NR, line 56. Filing 2011 tax returns free Rollovers and Other Transfers Assets can be rolled over or transferred from one QTP to another. Filing 2011 tax returns free In addition, the designated beneficiary can be changed without transferring accounts. Filing 2011 tax returns free Rollovers Any amount distributed from a QTP is not taxable if it is rolled over to another QTP for the benefit of the same beneficiary or for the benefit of a member of the beneficiary's family (including the beneficiary's spouse). Filing 2011 tax returns free An amount is rolled over if it is paid to another QTP within 60 days after the date of the distribution. Filing 2011 tax returns free Do not report qualifying rollovers (those that meet the above criteria) anywhere on Form 1040 or 1040NR. Filing 2011 tax returns free These are not taxable distributions. Filing 2011 tax returns free Members of the beneficiary's family. Filing 2011 tax returns free   For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary. Filing 2011 tax returns free Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. Filing 2011 tax returns free Brother, sister, stepbrother, or stepsister. Filing 2011 tax returns free Father or mother or ancestor of either. Filing 2011 tax returns free Stepfather or stepmother. Filing 2011 tax returns free Son or daughter of a brother or sister. Filing 2011 tax returns free Brother or sister of father or mother. Filing 2011 tax returns free Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. Filing 2011 tax returns free The spouse of any individual listed above. Filing 2011 tax returns free First cousin. Filing 2011 tax returns free Example. Filing 2011 tax returns free When Aaron graduated from college last year he had $5,000 left in his QTP. Filing 2011 tax returns free He wanted to give this money to his younger brother, who was in junior high school. Filing 2011 tax returns free In order to avoid paying tax on the distribution of the amount remaining in his account, Aaron contributed the same amount to his brother's QTP within 60 days of the distribution. Filing 2011 tax returns free If the rollover is to another QTP for the same beneficiary, only one rollover is allowed within 12 months of a previous transfer to any QTP for that designated beneficiary. Filing 2011 tax returns free Changing the Designated Beneficiary There are no income tax consequences if the designated beneficiary of an account is changed to a member of the beneficiary's family. Filing 2011 tax returns free See Members of the beneficiary's family , earlier. Filing 2011 tax returns free Example. Filing 2011 tax returns free Assume the same situation as in the last example. Filing 2011 tax returns free Instead of closing his QTP and paying the distribution into his brother's QTP, Aaron could have instructed the trustee of his account to simply change the name of the beneficiary on his account to that of his brother. Filing 2011 tax returns free Prev  Up  Next   Home   More Online Publications
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Report Outlines Changes for IRS To Ensure Accountability, Chart a Path Forward; Immediate Actions, Next Steps Outlined

Updated 7/15/2013 to reflect that the IRS will issue monthly updates. 

IR-2013-62, June 24, 2013

WASHINGTON ― Internal Revenue Service Principal Deputy Commissioner Danny Werfel today issued a report outlining new actions and next steps to fix problems uncovered with the IRS’ review of tax-exempt applications and improve the wider processes and operations in place at the IRS.

The three-part report covers a wide range of areas Werfel and his leadership team examined during the past month. The report cites actions to hold management accountable and identifies immediate steps to help put the process for approving tax-exempt applications back on track. Werfel also outlines actions needed to protect and improve wider IRS operations, ranging from compliance areas to taxpayer service.

“It is critical that the IRS takes steps to ensure accountability, address the problems uncovered in recent weeks and improve the operations of the IRS to continue to carry out our critical mission on behalf of the public,” Werfel said. “We have made a number of changes already, more are in the works and even more will develop as we move forward.”

Importantly, the initial IRS review shows no signs of intentional wrongdoing by IRS personnel or involvement by parties outside the IRS in the activities described in the recent TIGTA  report.  However, the report notes that investigations are ongoing, and that the IRS is committed to a full fact-finding effort to provide the public answers to these and other important questions.

“The IRS is committed to correcting its mistakes, holding people accountable, and establishing control elements that will help us mitigate the risks we face,” Werfel said. “This report is a critical first step in the process of restoring trust in this critical institution. We have more work in front of us, but we believe we are on the right track to move forward.”

Werfel’s report, titled “Charting a Path Forward at the IRS: Initial Assessment and Plan of Action,” covers three primary areas:

Accountability. This covers the steps being taken to ensure accountability for the mismanagement described in last month’s Treasury Inspector General for Tax Administration (TIGTA) report:

  • The report finds that significant management and judgment failures occurred, as outlined in the TIGTA report. These contributed to the inappropriate treatment of taxpayers applying for tax- exempt status. 
  • To address this, new leadership has been installed across all five executive management levels involved in the chain of command connected to these matters. In addition, the IRS has empaneled an Accountability Review Board to provide recommendations within 60 days (and later as needed) on any additional personnel actions that should be taken.

Fixing the Problems with the Review of Applications for Tax-Exempt Status. This part covers several process improvements underway to ensure that taxpayers are treated appropriately and effectively in the review of applications for tax-exempt status:  

  • The report outlines a new voluntary process to help certain applicants gain fast-track approval to operate as a 501(c)(4) tax-exempt entity if they are being reviewed for advocacy questions and  have been in our application backlog for more than 120 days. This self-certification process allows them a streamlined path to tax-exempt status if they certify they will operate within specified limits and thresholds of political and social welfare activities. In addition, the IRS has added new technical and program staff to assist with reviewing 501(c)(4) applications.
  • The IRS also suspended the use of any “be-on-the-lookout,” or BOLO lists in the application process for tax-exempt status.

Review of IRS Operations and Risks. The report identifies a series of actions to ensure taxpayers that selection criteria across the IRS are appropriate and that taxpayers are aware of how they can seek assistance if they have concerns about the IRS. The report further outlines steps underway to ensure that critical program or operational risks within the IRS are identified early, raised to the right decision-makers and shared timely with key stakeholders:

  • The report calls for establishing an Enterprise Risk Management Program to provide a common framework for capturing, reporting and addressing risk areas across the IRS.  This will improve timeliness in bringing information to the attention of the IRS Commissioner and other IRS leaders as well as key stakeholders to help prevent future instances of inappropriate treatment or mismanagement.
  • Although there is no current evidence that selection criteria in other IRS organizations is inappropriate, the nature of the problems identified in the tax-exempt application process warrants a review of certain process controls within the IRS.  The IRS will initiate a comprehensive, agency-wide review of compliance selection criteria.  Results will be shared with the Department of the Treasury, the IRS Oversight Board, and the Chairpersons of the House Ways and Means Committee and the Senate Finance Committee.
  • The IRS will initiate additional internal and external education and outreach about the role of the National Taxpayer Advocate in assisting taxpayers in resolving problems they encounter with the IRS. 

In addition to posting the report on IRS.gov, the IRS will provide monthly updates to the progress made on the TIGTA report’s recommendations and provide other developments related to this effort.

Related Items:

  • Recommended Actions — Status of recommended actions from the Treasury Inspector General for Tax Administration (TIGTA) on IRS's Exempt Organizations (EO) Division (updated as appropriate) and other information
  • FS-2013-7, Highlights from the IRS Report
  • FS-2013-8, IRS Offers New Streamlined Option to Certain 501(c)(4) Groups Caught in Application Backlog

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Page Last Reviewed or Updated: 04-Sep-2013

The Filing 2011 Tax Returns Free

Filing 2011 tax returns free 10. Filing 2011 tax returns free   Installment Sales Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Installment Sale of a Farm Installment MethodWhen to elect out. Filing 2011 tax returns free Revoking the election. Filing 2011 tax returns free More information. Filing 2011 tax returns free Figuring Installment Sale Income Payments Received or Considered Received ExampleSection 1231 gains. Filing 2011 tax returns free Summary. Filing 2011 tax returns free Introduction An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Filing 2011 tax returns free If you realize a gain on an installment sale, you may be able to report part of your gain when you receive each payment. Filing 2011 tax returns free This method of reporting gain is called the installment method. Filing 2011 tax returns free You cannot use the installment method to report a loss. Filing 2011 tax returns free You can choose to report all of your gain in the year of sale. Filing 2011 tax returns free Installment obligation. Filing 2011 tax returns free   The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you. Filing 2011 tax returns free Topics - This chapter discusses: The general rules that apply to using the installment method Installment sale of a farm Useful Items - You may want to see: Publication 523 Selling Your Home 535 Business Expenses 537 Installment Sales 538 Accounting Periods and Methods 544 Sales and Other Dispositions of Assets Form (and Instructions) 4797 Sales of Business Property 6252 Installment Sale Income See chapter 16 for information about getting publications and forms. Filing 2011 tax returns free Installment Sale of a Farm The installment sale of a farm for one overall price under a single contract is not the sale of a single asset. Filing 2011 tax returns free It generally includes the sale of real property and personal property reportable on the installment method. Filing 2011 tax returns free It may also include the sale of property for which you must maintain an inventory, which cannot be reported on the installment method. Filing 2011 tax returns free See Inventory , later. Filing 2011 tax returns free The selling price must be allocated to determine the amount received for each class of asset. Filing 2011 tax returns free The tax treatment of the gain or loss on the sale of each class of assets is determined by its classification as a capital asset, as property used in the business, or as property held for sale and by the length of time the asset was held. Filing 2011 tax returns free (See chapter 8 for a discussion of capital assets and chapter 9 for a discussion of property used in the business. Filing 2011 tax returns free ) Separate computations must be made to figure the gain or loss for each class of asset sold. Filing 2011 tax returns free See Sale of a Farm in chapter 8. Filing 2011 tax returns free If you report the sale of property on the installment method, any depreciation recapture under section 1245 or 1250 of the Internal Revenue Code is generally taxable as ordinary income in the year of sale. Filing 2011 tax returns free See Depreciation recapture , later. Filing 2011 tax returns free This applies even if no payments are received in that year. Filing 2011 tax returns free Installment Method An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Filing 2011 tax returns free A farmer who is not required to maintain an inventory can use the installment method to report gain from the sale of property used or produced in farming. Filing 2011 tax returns free See Inventory , later, for information on the sale of farm property where inventory items are included in the assets sold. Filing 2011 tax returns free If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. Filing 2011 tax returns free Electing out of the installment method. Filing 2011 tax returns free   If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year. Filing 2011 tax returns free   To make this election, do not report your sale on Form 6252. Filing 2011 tax returns free Instead, report it on Schedule D (Form 1040), Form 4797, or both. Filing 2011 tax returns free When to elect out. Filing 2011 tax returns free   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Filing 2011 tax returns free   However, if you timely file your tax return for the year the sale takes place without making the election, you still can make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Filing 2011 tax returns free Write “Filed pursuant to section 301. Filing 2011 tax returns free 9100-2” at the top of the amended return and file it where the original return was filed. Filing 2011 tax returns free Revoking the election. Filing 2011 tax returns free   Once made, the election can be revoked only with IRS approval. Filing 2011 tax returns free A revocation is retroactive. Filing 2011 tax returns free More information. Filing 2011 tax returns free   See Electing Out of the Installment Method in Publication 537 for more information. Filing 2011 tax returns free Inventory. Filing 2011 tax returns free   The sale of farm inventory items cannot be reported on the installment method. Filing 2011 tax returns free All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Filing 2011 tax returns free   If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. Filing 2011 tax returns free If you do not, each payment must be allocated between the inventory and the other assets sold. Filing 2011 tax returns free Sale at a loss. Filing 2011 tax returns free   If your sale results in a loss, you cannot use the installment method. Filing 2011 tax returns free If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale. Filing 2011 tax returns free Figuring Installment Sale Income Each payment on an installment sale usually consists of the following three parts. Filing 2011 tax returns free Interest income. Filing 2011 tax returns free Return of your adjusted basis in the property. Filing 2011 tax returns free Gain on the sale. Filing 2011 tax returns free In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Filing 2011 tax returns free You do not include in income the part that is the return of your basis in the property. Filing 2011 tax returns free Basis is the amount of your investment in the property for installment sale purposes. Filing 2011 tax returns free Interest income. Filing 2011 tax returns free   You must report interest as ordinary income. Filing 2011 tax returns free Interest is generally not included in a down payment. Filing 2011 tax returns free However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. Filing 2011 tax returns free Interest provided in the agreement is called stated interest. Filing 2011 tax returns free If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Filing 2011 tax returns free See Unstated interest , later. Filing 2011 tax returns free    You must continue to report the interest income on payments you receive in subsequent years as interest income. Filing 2011 tax returns free Adjusted basis and installment sale income (gain on sale). Filing 2011 tax returns free   After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts. Filing 2011 tax returns free A tax-free return of your adjusted basis in the property, and Your gain (referred to as “installment sale income” on Form 6252). Filing 2011 tax returns free Figuring adjusted basis for installment sale purposes. Filing 2011 tax returns free   You can use Worksheet 10-1 to figure your adjusted basis in the property for installment sale purposes. Filing 2011 tax returns free When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year. Filing 2011 tax returns free    Worksheet 10-1. Filing 2011 tax returns free Figuring Adjusted Basis and Gross Profit Percentage 1. Filing 2011 tax returns free Enter the selling price for the property   2. Filing 2011 tax returns free Enter your adjusted basis for the property     3. Filing 2011 tax returns free Enter your selling expenses     4. Filing 2011 tax returns free Enter any depreciation recapture     5. Filing 2011 tax returns free Add lines 2, 3, and 4. Filing 2011 tax returns free  This is your adjusted basis  for installment sale purposes   6. Filing 2011 tax returns free Subtract line 5 from line 1. Filing 2011 tax returns free If zero or less, enter -0-. Filing 2011 tax returns free  This is your gross profit     If the amount entered on line 6 is zero, Stop here. Filing 2011 tax returns free You cannot use the installment method. Filing 2011 tax returns free   7. Filing 2011 tax returns free Enter the contract price for the property   8. Filing 2011 tax returns free Divide line 6 by line 7. Filing 2011 tax returns free This is your gross profit percentage   Selling price. Filing 2011 tax returns free   The selling price is the total cost of the property to the buyer and includes the following. Filing 2011 tax returns free Any money you are to receive. Filing 2011 tax returns free The fair market value (FMV) of any property you are to receive (FMV is discussed at Property used as a payment under Payments Received or Considered Received ). Filing 2011 tax returns free Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property). Filing 2011 tax returns free Any of your selling expenses the buyer pays. Filing 2011 tax returns free Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Filing 2011 tax returns free Adjusted basis for installment sale purposes. Filing 2011 tax returns free   Your adjusted basis is the total of the following three items. Filing 2011 tax returns free Adjusted basis. Filing 2011 tax returns free Selling expenses. Filing 2011 tax returns free Depreciation recapture. Filing 2011 tax returns free Adjusted basis. Filing 2011 tax returns free   Basis is your investment in the property for installment sale purposes. Filing 2011 tax returns free The way you figure basis depends on how you acquire the property. Filing 2011 tax returns free The basis of property you buy is generally its cost. Filing 2011 tax returns free The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Filing 2011 tax returns free   While you own property, various events may change your original basis. Filing 2011 tax returns free Some events, such as adding rooms or making permanent improvements, increase basis. Filing 2011 tax returns free Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Filing 2011 tax returns free The result is adjusted basis. Filing 2011 tax returns free See chapter 6 and Publication 551, Basis of Assets, for more information. Filing 2011 tax returns free Selling expenses. Filing 2011 tax returns free   Selling expenses relate to the sale of the property. Filing 2011 tax returns free They include commissions, attorney fees, and any other expenses paid on the sale. Filing 2011 tax returns free Selling expenses are added to the basis of the sold property. Filing 2011 tax returns free Depreciation recapture. Filing 2011 tax returns free   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Filing 2011 tax returns free See Depreciation Recapture in chapter 9 and Depreciation Recapture Income in Publication 537. Filing 2011 tax returns free Gross profit. Filing 2011 tax returns free   Gross profit is the total gain you report on the installment method. Filing 2011 tax returns free   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Filing 2011 tax returns free If the property you sold was your home, subtract from the gross profit any gain you can exclude. Filing 2011 tax returns free Contract price. Filing 2011 tax returns free   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. Filing 2011 tax returns free Gross profit percentage. Filing 2011 tax returns free   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Filing 2011 tax returns free This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Filing 2011 tax returns free   The gross profit percentage generally remains the same for each payment you receive. Filing 2011 tax returns free However, see the example under Selling price reduced , later, for a situation where the gross profit percentage changes. Filing 2011 tax returns free Amount to report as installment sale income. Filing 2011 tax returns free   Multiply the payments you receive each year (less interest) by the gross profit percentage. Filing 2011 tax returns free The result is your installment sales income for the tax year. Filing 2011 tax returns free In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Filing 2011 tax returns free A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Filing 2011 tax returns free For a detailed discussion, see Payments Received or Considered Received , later. Filing 2011 tax returns free Selling price reduced. Filing 2011 tax returns free   If the selling price is reduced at a later date, the gross profit on the sale also will change. Filing 2011 tax returns free You then must refigure the gross profit percentage for the remaining payments. Filing 2011 tax returns free Refigure your gross profit using Worksheet 10-2. Filing 2011 tax returns free New Gross Profit Percentage — Selling Price Reduced. Filing 2011 tax returns free You will spread any remaining gain over future installments. Filing 2011 tax returns free    Worksheet 10-2. Filing 2011 tax returns free New Gross Profit Percentage — Selling Price Reduced 1. Filing 2011 tax returns free Enter the reduced selling  price for the property   2. Filing 2011 tax returns free Enter your adjusted  basis for the  property     3. Filing 2011 tax returns free Enter your selling  expenses     4. Filing 2011 tax returns free Enter any depreciation  recapture     5. Filing 2011 tax returns free Add lines 2, 3, and 4. Filing 2011 tax returns free   6. Filing 2011 tax returns free Subtract line 5 from line 1. Filing 2011 tax returns free  This is your adjusted  gross profit   7. Filing 2011 tax returns free Enter any installment sale  income reported in  prior year(s)   8. Filing 2011 tax returns free Subtract line 7 from line 6   9. Filing 2011 tax returns free Future installments     10. Filing 2011 tax returns free Divide line 8 by line 9. Filing 2011 tax returns free  This is your new  gross profit percentage*. Filing 2011 tax returns free   * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Filing 2011 tax returns free Example. Filing 2011 tax returns free In 2011, you sold land with a basis of $40,000 for $100,000. Filing 2011 tax returns free Your gross profit was $60,000. Filing 2011 tax returns free You received a $20,000 down payment and the buyer's note for $80,000. Filing 2011 tax returns free The note provides for monthly payments of $1,953 each, figured at 8% interest, amortized over four years, beginning in January 2012. Filing 2011 tax returns free Your gross profit percentage was 60%. Filing 2011 tax returns free You received the down payment of $20,000 in 2011 and total payments of $23,436 in 2012, of which $17,675 was principal and $5,761 was interest according to the amortization schedule. Filing 2011 tax returns free You reported a gain of $12,000 on the down payment received in 2011 and $10,605 ($17,675 X 60% (. Filing 2011 tax returns free 60)) in 2012. Filing 2011 tax returns free In January 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $1,483 a month amortized over the remaining three years. Filing 2011 tax returns free The new gross profit percentage, 47. Filing 2011 tax returns free 32%, is figured in Example — Worksheet 10-2. Filing 2011 tax returns free Example — Worksheet 10-2. Filing 2011 tax returns free New Gross Profit Percentage — Selling Price Reduced 1. Filing 2011 tax returns free Enter the reduced selling  price for the property 85,000 2. Filing 2011 tax returns free Enter your adjusted  basis for the  property 40,000   3. Filing 2011 tax returns free Enter your selling  expenses -0-   4. Filing 2011 tax returns free Enter any depreciation  recapture -0-   5. Filing 2011 tax returns free Add lines 2, 3, and 4. Filing 2011 tax returns free 40,000 6. Filing 2011 tax returns free Subtract line 5 from line 1. Filing 2011 tax returns free  This is your adjusted  gross profit 45,000 7. Filing 2011 tax returns free Enter any installment sale  income reported in  prior year(s) 22,605 8. Filing 2011 tax returns free Subtract line 7 from line 6 22,395 9. Filing 2011 tax returns free Future installments   47,325 10. Filing 2011 tax returns free Divide line 8 by line 9. Filing 2011 tax returns free  This is your new  gross profit percentage*. Filing 2011 tax returns free 47. Filing 2011 tax returns free 32% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Filing 2011 tax returns free You will report installment sale income of $6,878 (47. Filing 2011 tax returns free 32% of $14,535) in 2013, $7,449 (47. Filing 2011 tax returns free 32% of $15,742) in 2014, and $8,067 (47. Filing 2011 tax returns free 32% of $17,048) in 2015. Filing 2011 tax returns free Form 6252. Filing 2011 tax returns free   Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Filing 2011 tax returns free Attach it to your tax return for each year. Filing 2011 tax returns free Disposition of Installment Obligation If you are using the installment method and you dispose of the installment obligation, generally you will have a gain or loss to report. Filing 2011 tax returns free It is considered gain or loss on the sale of the property for which you received the installment obligation. Filing 2011 tax returns free Cancellation. Filing 2011 tax returns free   If an installment obligation is canceled or otherwise becomes unenforceable, it is treated as a disposition other than a sale or exchange. Filing 2011 tax returns free Your gain or loss is the difference between your basis in the obligation and its fair market value (FMV) at the time you cancel it. Filing 2011 tax returns free If the parties are related, the FMV of the obligation is considered to be no less than its full face value. Filing 2011 tax returns free Transfer due to death. Filing 2011 tax returns free   The transfer of an installment obligation (other than to a buyer) as a result of the death of the seller is not a disposition. Filing 2011 tax returns free Any unreported gain from the installment obligation is not treated as gross income to the decedent. Filing 2011 tax returns free No income is reported on the decedent's return due to the transfer. Filing 2011 tax returns free Whoever receives the installment obligation as a result of the seller's death is taxed on the installment payments the same as the seller would have been had the seller lived to receive the payments. Filing 2011 tax returns free   However, if the installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it is a disposition. Filing 2011 tax returns free The estate must figure its gain or loss on the disposition. Filing 2011 tax returns free If the holder and the buyer were related, the FMV of the installment obligation is considered to be no less than its full face value. Filing 2011 tax returns free More information. Filing 2011 tax returns free   For more information on the disposition of an installment obligation, see Publication 537. Filing 2011 tax returns free Sale of depreciable property. Filing 2011 tax returns free   You generally cannot report gain from the sale of depreciable property to a related person on the installment method. Filing 2011 tax returns free See Sale to a Related Person in Publication 537. Filing 2011 tax returns free   You cannot use the installment method to report any depreciation recapture income up to the gain on the sale. Filing 2011 tax returns free However, report any gain greater than the recapture income on the installment method. Filing 2011 tax returns free   The recapture income reported in the year of sale is included in your installment sale basis to determine your gross profit on the installment sale. Filing 2011 tax returns free   Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Filing 2011 tax returns free Report the depreciation recapture income in Part II of Form 4797 as ordinary income in the year of sale. Filing 2011 tax returns free    If you sell depreciable business property, prepare Form 4797 first in order to figure the amount to enter on line 12 of Part I, Form 6252. Filing 2011 tax returns free See the Form 6252 instructions for details. Filing 2011 tax returns free   For more information on the section 179 deduction, see Section 179 Expense Deduction in chapter 7. Filing 2011 tax returns free For more information on depreciation recapture, see Depreciation Recapture in  chapter 9. Filing 2011 tax returns free Payments Received or Considered Received You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. Filing 2011 tax returns free In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Filing 2011 tax returns free These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. Filing 2011 tax returns free However, as discussed later, the buyer's assumption of your debt is treated as a recovery of basis, rather than as a payment, in many cases. Filing 2011 tax returns free Buyer pays seller's expenses. Filing 2011 tax returns free   If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Filing 2011 tax returns free Include these expenses in the selling and contract prices when figuring the gross profit percentage. Filing 2011 tax returns free Buyer assumes mortgage. Filing 2011 tax returns free   If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply. Filing 2011 tax returns free Mortgage less than basis. Filing 2011 tax returns free   If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. Filing 2011 tax returns free It is considered a recovery of your basis. Filing 2011 tax returns free The contract price is the selling price minus the mortgage. Filing 2011 tax returns free Example. Filing 2011 tax returns free You sell property with an adjusted basis of $19,000. Filing 2011 tax returns free You have selling expenses of $1,000. Filing 2011 tax returns free The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 8% interest) in each of the next 4 years). Filing 2011 tax returns free The selling price is $25,000 ($15,000 + $10,000). Filing 2011 tax returns free Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Filing 2011 tax returns free The contract price is $10,000 ($25,000 − $15,000 mortgage). Filing 2011 tax returns free Your gross profit percentage is 50% ($5,000 ÷ $10,000). Filing 2011 tax returns free You report half of each $2,000 payment received as gain from the sale. Filing 2011 tax returns free You also report all interest you receive as ordinary income. Filing 2011 tax returns free Mortgage more than basis. Filing 2011 tax returns free   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Filing 2011 tax returns free The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Filing 2011 tax returns free   To figure the contract price, subtract the mortgage from the selling price. Filing 2011 tax returns free This is the total amount (other than interest) you will receive directly from the buyer. Filing 2011 tax returns free Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Filing 2011 tax returns free The contract price is then the same as your gross profit from the sale. Filing 2011 tax returns free    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Filing 2011 tax returns free Example. Filing 2011 tax returns free The selling price for your property is $9,000. Filing 2011 tax returns free The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Filing 2011 tax returns free Your adjusted basis in the property is $4,400. Filing 2011 tax returns free You have selling expenses of $600, for a total installment sale basis of $5,000. Filing 2011 tax returns free The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Filing 2011 tax returns free This amount is included in the contract price and treated as a payment received in the year of sale. Filing 2011 tax returns free The contract price is $4,000: Selling price $9,000 Minus: Mortgage (6,000) Amount actually received $3,000 Add difference:   Mortgage $6,000   Minus: Installment sale basis 5,000 1,000 Contract price $4,000   Your gross profit on the sale is also $4,000: Selling price $9,000 Minus: Installment sale basis (5,000) Gross profit $4,000   Your gross profit percentage is 100%. Filing 2011 tax returns free Report 100% of each payment (less interest) as gain from the sale. Filing 2011 tax returns free Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale. Filing 2011 tax returns free Buyer assumes other debts. Filing 2011 tax returns free   If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. Filing 2011 tax returns free   If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Filing 2011 tax returns free Compare the debt to your installment sale basis in the property being sold. Filing 2011 tax returns free If the debt is less than your installment sale basis, none of it is treated as a payment. Filing 2011 tax returns free If it is more, only the difference is treated as a payment. Filing 2011 tax returns free If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. Filing 2011 tax returns free These rules are the same as the rules discussed earlier under Buyer assumes mortgage . Filing 2011 tax returns free However, they apply only to the following types of debt the buyer assumes. Filing 2011 tax returns free Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Filing 2011 tax returns free Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Filing 2011 tax returns free   If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. Filing 2011 tax returns free The value of the assumed debt is then considered a payment to you in the year of sale. Filing 2011 tax returns free Property used as a payment. Filing 2011 tax returns free   If you receive property rather than money from the buyer, it is still considered a payment in the year received. Filing 2011 tax returns free However, see Trading property for like-kind property , later. Filing 2011 tax returns free Generally, the amount of the payment is the property's FMV on the date you receive it. Filing 2011 tax returns free Exception. Filing 2011 tax returns free   If the property the buyer gives you is payable on demand or readily tradable (see examples later), the amount you should consider as payment in the year received is: The FMV of the property on the date you receive it if you use the cash method of accounting, The face amount of the obligation on the date you receive it if you use an accrual method of accounting, or The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. Filing 2011 tax returns free See Unstated interest , later. Filing 2011 tax returns free Examples. Filing 2011 tax returns free If you receive a note from the buyer as payment, and the note stipulates that you can demand payment from the buyer at any time, the note is payable on demand. Filing 2011 tax returns free If you receive marketable securities from the buyer as payment, and you can sell the securities on an established securities market (such as the New York Stock Exchange) at any time, the securities are readily tradable. Filing 2011 tax returns free In these examples, use the above rules to determine the amount you should consider as payment in the year received. Filing 2011 tax returns free Debt not payable on demand. Filing 2011 tax returns free   Any evidence of debt you receive from the buyer that is not payable on demand is not considered a payment. Filing 2011 tax returns free This is true even if the debt is guaranteed by a third party, including a government agency. Filing 2011 tax returns free Fair market value (FMV). Filing 2011 tax returns free   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts. Filing 2011 tax returns free Third-party note. Filing 2011 tax returns free   If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Filing 2011 tax returns free Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. Filing 2011 tax returns free The excess of the note's face value over its FMV is interest. Filing 2011 tax returns free Exclude this interest in determining the selling price of the property. Filing 2011 tax returns free However, see Exception under Property used as a payment , earlier. Filing 2011 tax returns free Example. Filing 2011 tax returns free You sold real estate in an installment sale. Filing 2011 tax returns free As part of the down payment, the buyer assigned to you a $50,000, 8% third-party note. Filing 2011 tax returns free The FMV of the third-party note at the time of the sale was $30,000. Filing 2011 tax returns free This amount, not $50,000, is a payment to you in the year of sale. Filing 2011 tax returns free The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. Filing 2011 tax returns free The remaining 40% is interest taxed as ordinary income. Filing 2011 tax returns free Bond. Filing 2011 tax returns free   A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. Filing 2011 tax returns free For more information on the amount you should treat as a payment, see Exception under Property used as a payment , earlier. Filing 2011 tax returns free   If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. Filing 2011 tax returns free However, see Exception under Property used as a payment , earlier. Filing 2011 tax returns free Buyer's note. Filing 2011 tax returns free   The buyer's note (unless payable on demand) is not considered payment on the sale. Filing 2011 tax returns free However, its full face value is included when figuring the selling price and the contract price. Filing 2011 tax returns free Payments you receive on the note are used to figure your gain in the year received. Filing 2011 tax returns free Sale to a related person. Filing 2011 tax returns free   If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. Filing 2011 tax returns free For information on these rules, see the Instructions for Form 6252 and Sale to a Related Person in Publication 537. Filing 2011 tax returns free Trading property for like-kind property. Filing 2011 tax returns free   If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. Filing 2011 tax returns free See Like-Kind Exchanges in chapter 8 for a discussion of like-kind property. Filing 2011 tax returns free   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine installment sale income each year. Filing 2011 tax returns free The contract price is reduced by the FMV of the like-kind property received in the trade. Filing 2011 tax returns free The gross profit is reduced by any gain on the trade that can be postponed. Filing 2011 tax returns free Like-kind property received in the trade is not considered payment on the installment obligation. Filing 2011 tax returns free Unstated interest. Filing 2011 tax returns free   An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Filing 2011 tax returns free Interest provided in the contract is called stated interest. Filing 2011 tax returns free   If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. Filing 2011 tax returns free If Internal Revenue Code section 483 applies to the contract, this interest is called unstated interest. Filing 2011 tax returns free   If Internal Revenue Code section 1274 applies to the contract, this interest is called original issue discount (OID). Filing 2011 tax returns free   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Filing 2011 tax returns free Therefore, the buyer cannot deduct the unstated interest. Filing 2011 tax returns free The seller must report the unstated interest as income. Filing 2011 tax returns free Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity. Filing 2011 tax returns free   If the debt is subject to the Internal Revenue Code section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules. Filing 2011 tax returns free   Unstated interest reduces the stated selling price of the property and the buyer's basis in the property. Filing 2011 tax returns free It increases the seller's interest income and the buyer's interest expense. Filing 2011 tax returns free   In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the applicable federal rate (AFR). Filing 2011 tax returns free    The AFRs are published monthly in the Internal Revenue Bulletin (IRB). Filing 2011 tax returns free You can get this information by contacting an IRS office. Filing 2011 tax returns free IRBs are also available at IRS. Filing 2011 tax returns free gov. Filing 2011 tax returns free More information. Filing 2011 tax returns free   For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537. Filing 2011 tax returns free Example. Filing 2011 tax returns free You sell property at a contract price of $6,000 and your gross profit is $1,500. Filing 2011 tax returns free Your gross profit percentage is 25% ($1,500 ÷ $6,000). Filing 2011 tax returns free After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. Filing 2011 tax returns free The remainder (balance) of each payment is the tax-free return of your adjusted basis. Filing 2011 tax returns free Example On January 3, 2013, you sold your farm, including the home, farm land and buildings. Filing 2011 tax returns free You received $50,000 down and the buyer's note for $200,000. Filing 2011 tax returns free In addition, the buyer assumed an outstanding $50,000 mortgage on the farm land. Filing 2011 tax returns free The total selling price was $300,000. Filing 2011 tax returns free The note payments of $25,000 each, plus adequate interest, are due every July 1 and January 1, beginning in July 2013. Filing 2011 tax returns free Your selling expenses were $15,000. Filing 2011 tax returns free Adjusted basis and depreciation. Filing 2011 tax returns free   The adjusted basis and depreciation claimed on each asset sold are as follows:   Depreciation Adjusted Asset Claimed Basis Home* -0- $33,743 Farm land -0- 73,610 Buildings $31,500 35,130 * Owned and used as main home for at least 2 of the 5 years prior to the sale Gain on each asset. Filing 2011 tax returns free   The following schedule shows the assets included in the sale, each asset's selling price based on its respective value, the selling expense allocated to each asset, the adjusted basis of each asset, and the gain on each asset. Filing 2011 tax returns free The selling expense for each asset is 5% of the selling price ($15,000 selling expense ÷ $300,000 selling price). Filing 2011 tax returns free   Selling Selling Adjusted     Price Expense Basis Gain Home* $60,000 $3,000 $33,743 $23,257 Farm land  165,000  8,250  73,610  83,140 Buildings 75,000 3,750 35,130 36,120   $300,000 $15,000 $142,483 $142,517 * Owned and used as main home for at least 2 of the 5 years prior to the sale Depreciation recapture. Filing 2011 tax returns free   The buildings are section 1250 property. Filing 2011 tax returns free There is no depreciation recapture income for them because they were depreciated using the straight line method. Filing 2011 tax returns free See chapter 9 for more information on depreciation recapture. Filing 2011 tax returns free   Special rules may apply when you sell section 1250 assets depreciated under the straight line method. Filing 2011 tax returns free See the Unrecaptured Section 1250 Gain Worksheet in the Instructions for Schedule D (Form 1040). Filing 2011 tax returns free See chapter 3 of Publication 544, Sales and Other Dispositions of Assets, for more information on section 1250 assets. Filing 2011 tax returns free Installment sale basis and gross profit. Filing 2011 tax returns free   The following table shows each asset reported on the installment method, its selling price, installment sale basis, and gross profit. Filing 2011 tax returns free     Installment     Selling Sale Gross   Price Basis Profit Farm land $165,000 $73,610 $83,140 Buildings 75,000 35,130 36,120   $240,000 $108,740 $119,260 Section 1231 gains. Filing 2011 tax returns free   The gain on the farm land and buildings is reported as section 1231 gains. Filing 2011 tax returns free See Section 1231 Gains and Losses in chapter 9. Filing 2011 tax returns free Contract price and gross profit percentage. Filing 2011 tax returns free   The contract price is $250,000 for the part of the sale reported on the installment method. Filing 2011 tax returns free This is the selling price ($300,000) minus the mortgage assumed ($50,000). Filing 2011 tax returns free   Gross profit percentage for the sale is 47. Filing 2011 tax returns free 70% ($119,260 gross profit ÷ $250,000 contract price). Filing 2011 tax returns free The gross profit percentage for each asset is figured as follows:   Percent Farm land ($83,140 ÷ $250,000) 33. Filing 2011 tax returns free 256 Buildings ($36,120 ÷ $250,000) 14. Filing 2011 tax returns free 448 Total 47. Filing 2011 tax returns free 70 Figuring the gain to report on the installment method. Filing 2011 tax returns free   One hundred percent (100%) of each payment is reported on the installment method. Filing 2011 tax returns free The total amount received on the sale in 2013 is $75,000 ($50,000 down payment + $25,000 payment on July 1). Filing 2011 tax returns free The installment sale part of the total payments received in 2013 is also $75,000. Filing 2011 tax returns free Figure the gain to report for each asset by multiplying its gross profit percentage times $75,000. Filing 2011 tax returns free   Income Farm land—33. Filing 2011 tax returns free 256% × $75,000 $24,942 Buildings—14. Filing 2011 tax returns free 448% × $75,000 10,836 Total installment income for 2013 $35,778 Reporting the sale. Filing 2011 tax returns free   Report the installment sale on Form 6252. Filing 2011 tax returns free Then report the amounts from Form 6252 on Form 4797 and Schedule D (Form 1040). Filing 2011 tax returns free Attach a separate page to Form 6252 that shows the computations in the example. Filing 2011 tax returns free If you sell depreciable business property, prepare Form 4797 first in order to figure the amount to enter on line 12 of Part I, Form 6252. Filing 2011 tax returns free Section 1231 gains. Filing 2011 tax returns free   The gains on the farm land and buildings are section 1231 gains. Filing 2011 tax returns free They may be reported as either capital or ordinary gain depending on the net balance when combined with other section 1231 losses. Filing 2011 tax returns free A net 1231 gain is capital gain and a net 1231 loss is an ordinary loss. Filing 2011 tax returns free Installment income for years after 2013. Filing 2011 tax returns free   You figure installment income for the years after 2013 by applying the same gross profit percentages to the payments you receive each year. Filing 2011 tax returns free If you receive $50,000 during the year, the entire $50,000 is considered received on the installment sale (100% × $50,000). Filing 2011 tax returns free You realize income as follows:   Income Farm land—33. Filing 2011 tax returns free 256% × $50,000 $16,628 Buildings—14. Filing 2011 tax returns free 448% × $50,000 7,224 Total installment income $23,852   In this example, no gain ever is recognized from the sale of your home. Filing 2011 tax returns free You will combine your section 1231 gains from this sale with section 1231 gains and losses from other sales in each of the later years to determine whether to report them as ordinary or capital gains. Filing 2011 tax returns free The interest received with each payment will be included in full as ordinary income. Filing 2011 tax returns free Summary. Filing 2011 tax returns free   The installment income (rounded to the nearest dollar) from the sale of the farm is reported as follows: Selling price $190,000 Minus: Installment basis (108,740) Gross profit $81,260     Gain reported in 2012 (year of sale) $35,778 Gain reported in 2013:   $50,000 × 47. Filing 2011 tax returns free 70% 23,850 Gain reported in 2014:   $50,000 × 47. Filing 2011 tax returns free 70% 23,850 Gain reported in 2015:   $50,000 × 47. Filing 2011 tax returns free 70% 23,850 Gain reported in 2016:   $25,000 × 47. Filing 2011 tax returns free 70% 11,925 Total gain reported $119,253 Prev  Up  Next   Home   More Online Publications